Insights

How prepared manufacturers can win — with or without a border-adjusted tax

With all of the demands on manufacturers in getting ahead in today’s marketplace, management rarely is able to take time to understand the nuances of tax reform proposals. The political environment is so unsettled that few could predict if, when or how tax laws may change. We have seen it played out similarly before: Tax legislation gets batted around for so long that there is little advantage to study it until, or if, it becomes law.

Although historically it may have been impractical to pay attention to tax reform debate, the debate in 2017 looks and feels different — and may end much differently.

Since the ratification of the 18th Amendment in 1913 and the War Revenue Act of 1917, the U.S. has imposed material statutory income tax rates on goods and services originating within the U.S. A century later, the U.S. has kept the same basic tax system in place yet 160 other countries have adopted tax systems with generally lower income tax rates, based on where goods and services are consumed and, in most cases, combined with a value-added tax (VAT). Some law and policymakers are actively debating drastic changes to the U.S. tax code, which could bring lower statutory rates and a consumption-based tax manifested in a “border-adjusted tax,” or BAT. In some cases, this could be considered a move toward implementing a VAT.

Is the blueprint including BAT still in play?

In a report issued in June 2016, some members of the U.S. House of Representatives’ Ways and Means Committee issued a proposed tax reform blueprint calling it “a 21st century tax system built for growth.” Proposed in the blueprint were dramatically lower income tax rates, immediate write-off of capital expenses (capex), elimination of deductions for interest expense for businesses and state income taxes for individuals plus a repatriation tax holiday. It also includes the debated border-adjusted destination-based cash flow tax model.

On April 26, 2017, the Trump administration released details of its plan for tax reform. It proposed reducing the business income tax rate to 15 percent, cutting the number of individual income tax brackets to three and eliminating the net investment income tax, the alternative minimum tax and estate taxes, among other ideas.

While the White House plan did not mention the idea of a BAT, Treasury Secretary Steven Mnuchin said in a May 2017 Bloomberg BNA article, “There are many aspects we like. There are certain things that we’re concerned about. We don’t think it works in its current form.” He added that despite concerns, he was working with Ways and Means Committee Chairman Kevin Brady and would consider revisions made to the proposal.

Further, Utah Senator Mike Lee (R) recently said that the border-adjustment tax is dead. “The White House doesn’t want it. A number of us in the Senate have real concerns with the border adjustment tax,” Lee said May 31 on Fox News. He said he thinks that part of the tax reform plan can't advance in the Senate.

There have been arguments for and against the BAT, both in public and formal political forums such as Ways and Means Committee hearings as well as in the commercial sector.

BAT or not, why should one care?

Political support for BAT may be eroding but the underlying arguments for its consideration have not changed. The motivation is rooted in the effort to stimulate new life and energy into the American manufacturing sector. Some U.S. policymakers believe the first step should be relative and to lower U.S. statutory tax rates to be comparable to other countries. If income tax rates are significantly reduced, there needs to be a way to recover lost tax revenue. BAT could be a path to recapture that revenue. Many economists believe a BAT could generate $1 trillion over the next 10 years. That revenue generation potential is a big reason to believe that tax reform could, in fact, be quite radical and include some elements of a BAT or maybe some other consumption-based tax system.

Many U.S. policymakers have publicly stated their desire to grow the economy by bringing back production activities to the U.S. This highly visible objective can be seen as another motivating reason to advance BAT or other consumption-based features.

Despite resistance to BAT, current U.S. policymakers continually resurface the underlying rationale for the BAT proposal. Congressman Dave Reichert , former chairman and senior member of the House Ways and Means Subcommittee on Tax Policy, said, “The Committee [is] focused on a simpler, fairer, pro-growth tax plan that works for the American people and will make us more competitive internationally.”

In addition, the president’s tax plan lamented the fact too many jobs have been shipped overseas. At the G7 summit in May, Mnuchin initiated a discussion on tax reform (which was not on the agenda) and openly stated that the U.S. had the right to be a little “protectionist.” Finally, Speaker of the House Paul Ryan advocated in May for “more risk-taking, more job creation, more businesses being built and more manufacturing occurring in America.” These are a few public statements that indicate some momentum around unprecedented tax policy changes including various territorial or consumption-based models.

The motivation to enact tax legislation that favors U.S. production activities is strong among some U.S. policymakers. Whether or not that legislation includes BAT or something similar, tax reform has the potential to dramatically reshape the income tax landscape in the U.S.

A potential change in how business is done

Tax laws influence nearly every aspect of American business. It stands to reason that any substantial changes to U.S. tax laws would have profound effects on how U.S. business is conducted. Some form of a consumption-based tax system would considerably alter operations for almost every business in the U.S. The potential impact on supply chains, raw material pricing, consumer pricing models, long-term supply contracts and attractiveness of exports should be considered. There could also be significant effects on demand for domestically produced components, facility expansions and skilled labor. A BAT or consumption-based tax system would influence the value of the U.S. dollar relative to foreign currencies with consequences for the finances of every affected business. Expansion and capex plans would be altered by immediate expensing and no-interest deductions which are included under many tax reform proposals. Should this kind of tax reform occur, it would change the business economy in the U.S. in fundamental ways.

Of course, taxes have never been, nor should they ever be, the single critical factor when making sound business decisions. However, they represent one significant component to be evaluated when making business plans.

Early “adapters” have the advantage

Being the first to adapt to a changing marketplace could be a major competitive advantage for any company in any industry. As an example, a manufacturer that currently purchases raw materials from overseas can deduct the cost of the raw materials irrespective of where they are purchased. Under the House blueprint, raw material costs would not be deductible, resulting in a 20 percent tax on the manufacturer’s imported materials.

Next, presume this domestic manufacturer could purchase similar raw materials from a U.S. producer at a 10 percent higher price than the foreign source. The cost of the domestically produced raw material would be deductible under the House blueprint. The 10 percent higher price would be offset by the 20 percent BAT tax had the materials been imported from a foreign source. In addition, if there is a limited source of domestically produced raw materials, the first manufacturer to act and lock in long-term contracts with U.S. suppliers may have an edge over competitors.

What should you do?

In a changing business environment, the first to adapt are often the winners in the marketplace. However, one must first understand potential and enacted changes before they can determine how best to adapt. The more significant the changes, the more valuable early adaption can be. While it is far too early in the tax reform process to act, you should be examining your options and drafting plans as things progress.

The debate over tax reform will be ongoing. In addition, the current political environment is generating uncertainty about whether any significant tax reform will be passed. Still, businesses need to understand the prospects of tax reform and how they would influence the way business is done in the U.S. If we get the dramatic and fundamental tax reform proposed by the House blueprint, the first to understand it will be the best positioned to take advantage. It is one way for you and your business to be a step ahead of your competitors.

Manufacturers need to consider potential tax reform in their planning and prepare for issues such as long-term foreign supply contracts for raw materials, exposure of possible foreign exchange rates and expanding domestic production. Understanding the details of the different tax reforms being proposed equips you to rethink your long-term growth strategy. More importantly, it prepares you for quicker adaption and helps your business compete and win in a changing marketplace.

Baker Tilly established the Center for the Return of Manufacturing (CFRM) in 2017 to help businesses anticipate and leverage tax, trade and economic policy changes.

One of the CFRM’s primary areas of focus is helping the manufacturing industry meet the challenges of policies such as the House blueprint. In fact, members of CFRM created the Baker Tilly Blueprint Tax Calculator. This six-point questionnaire will let you know how dramatic tax reform could financially affect your business.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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